A staff discussion note was published on the IMF website on 15 June 2015 with the title “Causes and Consequences of Income Inequality: A Global Perspective”.
The analysis finds that the gap between rich and poor in advanced economies is the widest it has been for some decades. In emerging markets and developing economies the picture is more mixed but inequity in access to education, healthcare and finance continues. The analysis suggests that income inequality, in situations where the share of income of the top 20% increases, has an adverse effect on GDP growth. An increase in the income share of the lowest 20% is however linked to higher GDP growth. The top 1% now accounts for around 10% of income in advanced economies. Inequality of wealth is more extreme than inequality of income in both advanced economies and developing countries.
The study explores a diverse range of countries to look at the explanation for divergent trends in inequality developments. The analysis finds that technological progress and the resulting increased skill premium, and the decline of some labor market institutions, have contributed to inequality in both advanced and emerging countries. Globalization has reinforced this but has played a smaller role.
The paper concludes that policies focusing on the poor and middle class can mitigate inequality. Better access to education and healthcare, and targeted social policies, can help raise the income share of these groups. The appropriate policies will depend on the drivers in a particular country and the policy and institutional setting. Advance economies need to focus on reforms to increase human capital and skills, and make tax systems more progressive. In emerging markets and developing countries there must be greater financial inclusion and incentives for lowering informality in the economy.
The note explains that fiscal policy can be an important tool for reducing inequality by ensuring macroeconomic stability. Fiscal redistribution if done in a way that is consistent with other macroeconomic policies can raise the income share of the poor and middle class and thereby support growth. The redistributive role of fiscal policy can be strengthened by a greater emphasis on wealth taxes and property taxes; more progressive income taxation; removing opportunities for tax avoidance and evasion; better targeting of social benefits and minimizing efficiency costs (such as reduced incentives to work and save).
Governments could also remove tax expenditures that benefit high income groups the most. Tax relief in the form of reduced taxation of capital gains, stock options and carried interest could be removed in order to increase equity. The additional revenue from these measures could be used to reduce marginal income tax rates on labor.
In emerging economies and developing countries government spending could ensure better access to education and healthcare. Targeted conditional cash transfers and efficient social safety nets could help incomes of the poor. This increased government spending could be funded by greater revenue mobilization, reduction of tax loopholes, reduction tax evasion and elimination of less well targeted spending such as certain subsidies.
Education, financial inclusion and well designed labor market policies and institutions can also reduce inequality without affecting efficiency. In emerging markets and developing countries labor markets could be made more inclusive and incentives created for lowering the informality in the economy. Policies that reduce tax, financial and regulatory constraints could expand employment in the formal sector by reducing incentives for firms to operate informally.
